Understanding The 1031 Exchange
The Tax Code May Help You Own A Home In Tucson
A 1031 exchange is a type of real estate transaction that can defer any taxable gains. The key to a 1031 is an exchange is that the acquired new property must be “like-kind” property. The advantage of a 1031 exchange is that income taxes are not paid at the time of the exchange.
There are four classifications of Real Estate established by the Internal Revenue Service. The IRS’s definition for 1031 exchange property is:
- Primarily held for sale. (Dealer Property)
- Held for personal use. (Personal Property)
- Held for investment. (Investment Property)
- Held for productive use in a trade or business. (Business Property)
Only classifications 3 & 4 qualify for a 1031 Exchange. Property received and the property sold “or given” must be of “like-kind“. The use of the property determines its classification. Should the receiver of the property use it differently, it does not affect your tax status.
Like Kind Exchange Basics
To avoid any current taxable gain, you also must avoid receiving any “boot.” Boot means cash and/or property that is not like-kind property.
When mortgaged boot also includes the excess of the mortgage on the sold property.
If you receive any boot, you will incur a tax liability on any gain equal to the lesser of:
- The value of the boot or
- Your total gain on the transaction based on fair market values.
In the case where the boot is small, taxes will be small as well. On the other hand, if you receive lots of boot, you could have a big taxable gain.
To avoid receiving any boot, swap a less-valuable property for a more-valuable property. That way, you’ll be paying boot rather than receiving it.
Paying boot won’t trigger a taxable gain on your side of the deal.
The Key Is “Like Kind”
Remember “like kind” is based on your use of the property. Its grade or quality is not considered. Section 1031 treatment is not applied to property held outside the United States.
Vacation homes do not qualify for Section 1031 treatment if used solely for personal use. But may qualify if rented. It must pass a use test each year. Search Condos For Sale in Tucson AZ.
This information is provided as general background on the subject of Section 1031 exchanges. It does not cover all issues or rules on the subject. It is not a substitute for advice from your professional tax adviser. You should always consult your financial or tax adviser on such matters.
Like-Kind Exchange Tax Basics
The deferred gain in Section 1031 swap rolls over into the replacement property. It remains untaxed until you sell that property in a taxable transaction.
Now should you die and still own a 1031 exchange property, the tax basis is “stepped up” to Fair Market Value. FMV is set as of the date of death — or as of six months later if your executor makes that choice.
This beneficial washes away most – or all – of the taxable gain on the replacement property.
If your heirs sell the property, they would only be taxed on gain that accrued after the magic date, if any. Nice!
Section 1031 rules and the step-up-on-death are why real estate helps make fortunes.
Considering A Home In Tucson, AZ?
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A 1031 exchange may be one way to buy a home in Tucson. But it is only for investment properties not primary homes.
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